Should student loans be cheaper at Harvard?

JenWieczner

Atilin/Wikipedia

Harvard Yard, the heart of Harvard University in Cambridge, Mass.

The Federal government charges students uniform interest rates no matter how likely they are to default.

If the government ran its student loan programs the way banks do, Ivy Leaguers would probably get a steep discount, those at state universities would pay a bit more, and many at community colleges and for-profit schools would be deemed subprime borrowers.

No college degree guarantees one will be able to afford to pay off their student loans, but Ivy League borrowers rarely default on their debt: Just 1% of Harvard University students defaulted within three years of their loans coming due in 2009, according to Department of Education data released last week; and at the higher end, just under 3% of Columbia University alumni defaulted. Compare that with for-profit schools such as the University of Phoenix, where 26% of students defaulted in that same time period -- nearly twice the national average.

Student Loan DefaultsDefaults within three years of loans coming due. (Source: U.S. Department of Education)

School Type

Rate

# of Students in Default

Ivy League

1.6%

292

Private Colleges

7.5%

63,047

Public Colleges

11.0%

196,032

For-Profit Schools

22.7%

229,315

But the risk of default, while commonly priced into the interest rates banks charge on loans, is not a factor in federal student financial-aid packages. The Stafford loan, the most common federal student loan and the only type included in the default rate report, charges interest of up to 6.8% (some eligible students receive subsidized federal loans at a lower rate, but this is not affected by the school they attend).

Private lenders, on the other hand, likely account for default risk factors in the interest rates they charge students on their loans, including the student’s intended major, the college’s graduation rate, and the default rate of other borrowers at the school, according to Greg McBride, senior financial analyst at Bankrate.com.

Federal student loans are not subject to these considerations, however, because the government’s primary goal in aiding students is to ensure access to higher education for people of all income levels, not to make a profit, though the federal program is profitable despite the defaults, says Mark Kantrowitz, the publisher of student loan website FinAid.org. Charging higher interest rates on loans for attending schools with higher default rates could amount to discrimination, he says, because those schools tend to have a higher proportion of low-income and minority students. “Besides being akin to redlining, it’s also contrary to the government’s goal,” he says.

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“The whole purpose for these programs is to give students an opportunity to pursue a higher education that they may otherwise not be able to pursue because of the situation they’re in financially,” says an Education Department spokesman, noting that the interest rates on student loans are set by Congress, and that students taking out loans to enter college typically have no credit history because they are too young to own a home or have a credit card.

Student loan default rates are high even at schools that are typically the least expensive to attend, such as community colleges and for-profit universities, because those schools attract a population with a higher risk of default. Indeed, some low-income students nicknamed “Pell runners” take out loans to attend the cheapest schools with no intention of repaying or even completing coursework, instead pocketing the funds as a sort of welfare, Kantrowitz says. As for why the default rate is so high at for-profit institutions, a spokesman for the University of Phoenix says students who start -- but fail to finish their degree -- account for much of the problem. The default rates for those who actually graduate is only 4%. The school is also working to educate prospective students on the financial commitment of enrolling and on borrowing responsibly, the spokesman says.

Overborrowing is also a chronic problem among students at all types of schools, which could contribute to the persistently high default rates, Kantrowitz says. Federal law currently sets the same ceiling on student loans whether the student is pursuing a Bachelor’s degree or a less costly certificate, which typically leads to fewer job prospects, he adds: “If students are getting a degree that isn’t going to be as lucrative, they shouldn’t be borrowing as much.”

There have been Congressional proposals that colleges share in the risk of default with the government, in the hope that the schools would work to prevent defaults, but these efforts have failed to gain traction because studies showed that colleges would raise tuition to cover the defaults, thereby negating any benefit.

But some federal rules are designed to lower the risk of student loan default by forcing students to better manage their finances and consider how much they actually need to borrow. The 30-day delay rule, for example, requires that loans only be disbursed a month after students request aid. While schools with a student loan default rate of less than 10% can get a waiver for this rule, many choose not to, according to Kantrowitz, because they find that students decide to borrow less after the 30-day waiting period. “By making them jump through a little bit of hoops, they’re less likely to go overboard in debt,” Kantrowitz says.

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